An options contract is a derivative meaning, that the price of it is derived from a stock. So you are not actually purchasing the stock, but rather it is a binding contract between the buyer and seller to purchase or sell the stock at a specific price. Because of the ability to use leverage with stock options, you have the potential to make a lot more money than you can with the underlying stock. However, they are also a lot more complex to trade than stocks are.
Learn to trade stocks. Since the price of options is based on the price of stocks, you will need to understand how and why stocks move before you begin trading options. A good place to learn some of the basics of stock trading is over at Investopedia. They have lots of free lessons, mock exams and articles for the beginning investor. Another place is MoneyCentral.com. Here you will find a stock screening tool that will help you to analyze your stocks. TradingMarkets.com is also a good place for a beginning investor to learn. There are lots of free articles and tutorials to help you begin.
Understand the basics of options trading. OptionTradingPedia.com will give you the basics of all the different trading strategies. There are literally dozens to learn. The best thing to do is to learn the very basics of how a put and call works, and then you can begin adding the more complex strategies such as using spreads and covered call writing. All of the articles and lessons on this site are free.
Another good place to go is Optionetics. This site has both free and paid tools, including the quarterly earnings calendar. This is important, since you shouldn't trade stocks within a day or two of their earnings announcements, which can cause the stocks to become extremely volatile.
Get a simulator before you trade with real money. It goes without saying that you should practice with virtual money before you begin trading with the real thing. A few simulators that you can try out include Investopedia, MockTrading and StockTrak. As of 2010, these are all offered free of charge.
Once you are comfortable enough to trade, you will want to experiment with buying puts and calls. With a call, the value goes up as the price of the stock goes up. The value of a put will go up as the stock goes down. A simple way to think of it is “Call Up” and “Put Down.” The advantage of buying puts and calls over buying the stock outright is in the leverage.
For example, you can purchase 100 shares of a stock trading at $25 for $2500. But you can purchase a call that controls 100 shares of stock for about $150. If the stock goes up by $5, you will make $500 after purchasing the shares. You will also make the same $500 with the call, but it only took you $150 to get in. This is a very simple explanation, and there are lots of other factors to consider when investing in options.
Once you are ready to invest your money for real, you will need to find an options broker. A few that you might wish to consider are OptionsXpress, ETrade and Ameritrade. These brokers have all been around for more than 10 years and are members of the SIPC (Securities Investment Protection Corporation) and FINRA (Financial Investment Regulatory Authority). These are the organizations that regulate brokerage houses.
Palmer Owyoung holds a Master of Arts in international business from the University of California at San Diego and a Bachelor of Arts in sociology from the University of California at Santa Barbara and is a trained molecular biologist. He has been a freelance writer since 2006. In addition to writing, he is a full-time Forex trader and Internet marketer.